Buying a home -- especially your first home -- is one of the most exciting moments of your life. But it can also be one of the most expensive, especially if we're talking about mortgage lenders and costly added charges that can put your financial freedom on hold for decades.
That's why it pays to know the mortgage lender's game. Whether you've been paying on a mortgage for several years now or you're taking out your first mortgage, there are many simple strategies you can use today to potentially save thousands of dollars in avoidable mortgage fees or even pay off your home 10 years early.
Ready to start saving? Here are four tips that mortgage lenders don't want you to know.
1. Avoid PMI Costs by Putting Down 20% (or Get as Close as You Can!)
If you don't put down 20% in cash toward a home when you apply for a mortgage or refinance, lenders will require that you buy private mortgage insurance (PMI) to protect them against potential default. And while they'll tell you PMI costs 'just 1%' of the amount you borrow, it could end up costing you $3,000 per year in often-avoidable premiums on a $300,000 mortgage.
While not everyone can afford to put 20% down, it's worth getting as close to that magic figure as possible, because you can ask your lender to cancel PMI as soon as your mortgage balance falls to 80% of your home's original appraisal value.
If you're shopping for a home, consider making your budget five times what you have in down payment cash. If you already have a mortgage and you're paying PMI, then you could pay extra toward the principal each month to build your equity closer to the 20% mark. Or you could refinance into a lower-rate mortgage if your home's value has appreciated considerably, as the new lender may refigure your equity to be above the 20% threshold.
2. Save Thousands in Interest Charges by Shopping Lenders
You may love 'your bank,' but with lending comparison tools making it easy to potentially save tens of thousands in interest charges on a mortgage or refinance, it's worth taking the time to shop around.
Even small rate differences can amount to big savings. Let's say you're shopping 30-year-fixed mortgage loans to borrow $300,000 for a home or refinance. Assuming the lenders' closing costs are equal, going with a 5% APR loan instead of a 5.5% APR loan would save you a whopping $33,445 in interest charges ($313,212 in interest versus $279,767) over 30 years.
Still like your lender too much to switch? Get your best offer from a competitor in writing and bring it to them. Many times they'll match the offer to keep your business while saving you thousands.
3. Keep Your Mortgage Affordable by Avoiding ARM Loans
Many lenders tempt cash-strapped buyers into getting 'more affordable' adjustable-rate mortgages (ARMs), which can carry first-year interest rates from one point to half a percentage point lower than a comparable fixed-rate mortgage. But that could be a big mistake: because the rates on ARMs begin adjusting along with fluctuations in the bond market after the first year, your mortgage payments could quickly balloon to unaffordable levels if interest rates go up.
You can see how expensive your monthly payments on a $300,000 ARM could get if the Federal Reserve were to raise interest rates by 1% annually (as it did in 2008) over a five-year period in the table below. You'll also see why it's probably worth the peace of mind to stick with a traditional fixed-rate mortgage instead of an ARM.
Monthly Payments on 30-year Fixed Mortgage vs ARM
| Monthly Rate (Current) | Monthly Payment (Initially) | Monthly Payment (Year 1) | Monthly Payment (Year 2) | Monthly Payment (Year 3) | Monthly Payment (Year 4) | Monthly Payment (Year 5) | |
|---|---|---|---|---|---|---|---|
| 30-Year Fixed-Rate Mortgage | 4.0% | $1,432 | $1,432 | $1,432 | $1,432 | $1,432 | $1,432 |
| One-Year ARM | 3.5% | $1,347 | $1,515 | $1,689 | $1,867 | $2,048 | $2,231 |
| *This hypothetical scenario is for a $300,000 mortgage (not including PMI, insurance, or taxes) and assumes interest rates and ARM rates rise 1% each year for five years. |
4. Pay off Your Mortgage 10 Years Early With Little Extra Effort
Imagine paying off your 30-year fixed mortgage 10 years sooner than you planned. Then imagine putting that extra $2,000 or $4,000 you were paying each month (that's $24,000 or $48,000 a year!) toward the retirement of your dreams or taking many well-deserved vacations. It's possible to do -- and far easier than lenders want you to think.
If you were to pay just $450 extra per month toward the principal on a $300,000 mortgage (fixed 30-year at 5% APR) you recently took out, then you could have your home paid off 10 years early while saving $101,343 in interest charges. And even if you've already been paying a similar mortgage for the past five or 10 years, putting an extra $450 toward the principal would allow you to pay off your home nine or six years early, respectively.
(You can learn even more pain-free, early-payoff secrets in 3 Ways to Pay Off Your Mortgage up to 15 Years Early.)
Know the lender's game and don't pay charges that are completely avoidable. Put as much money down as you can, avoid being lured by ARM loans, invest a little extra toward your principal, and always shop around for the best mortgage rates for a home or refinance. It won't take much to save tens of thousands of dollars from avoided charges -- or to start dreaming of what you'll do with all that extra money!
